The FDR Framework is the backbone for a 21st century financial system. Under this framework, governments ensure that every market participant has access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to analyze this data because they are responsible for all gains and losses.

Thursday, April 19, 2012

WSJ's David Reilly lays out why ultra transparency is needed when looking at bank trading performance

In his Heard on the Street column, the Wall Street Journal's David Reilly looks at how the current level of disclosure is inadequate for investors to determine how Wall Street makes its money.

Based on the current level of disclosure by Wall Street firms,

No matter how much sun shines on Wall Street, it isn't bright enough for investors to see what really goes on in investment banks.

Trading performance in the first quarter bounced back from a dismal period late last year as fears over a European meltdown receded.

But divergent performances underscore how little insight investors really have into how banks make their money.

This lack of insight confirms the fact that the current level of required and voluntary disclosure leave Wall Street firms as transparent as black boxes.

In reporting upbeat results Thursday, Morgan Stanley said revenue of about $2.6 billion in its fixed income, commodities and currency business was up 34% year over year, excluding the impact of changes in the value of its own debt. Goldman, meanwhile, reported earlier this week that revenue for its same operation, at about $3.4 billion, was down 20% from a year earlier.

What gives? Some of it may be down to differences in firms' risk appetite. There may be varying levels of activity by clients. A portion may be due to business mix—currency products were particularly strong last quarter—or how different firms report results. Mark-ups of inventory in rising markets may also play a role. Additionally, Morgan, which has been rebuilding its trading operation for the past year, is likely gaining back market share lost coming out of the financial crisis.

While all are possible factors, investors can't really say for sure what drives trading results....

With the right level of disclosure it would be possible for investors to know for sure what drives trading results.

This level of disclosure is ultra transparency where the banks disclose on an on-going basis their current asset, liability and off-balance sheet exposure details. With this information, market participants could determine exactly how these banks generated their trading results.

As Morgan chief James Gorman said, the quarter showed the firm is headed in the right direction. It still needs, though, to string together a series of similarly strong quarters and show that it can consistently post returns in excess of its cost of capital, estimated at about 10%....

But as good as they were, especially compared with Goldman's, investors are still left scratching their heads when gauging how trading businesses will perform next time around.

The bottom-line is until the banks provide ultra transparency, investors do not have the information they need to accurately gauge how the trading business will perform.

About this blog

A blog on all things about Wall Street, global finance and any attempt to regulate it. In short, the future of banking and the global financial system.

This blog will be used to discuss and debate issues not just for specialists, but for anyone who cares about creating good policies in these areas.

At the heart of this blog is the FDR Framework which uses 21st century information technology to combine a philosophy of disclosure with the practice of caveat emptor (buyer beware).

Under the FDR Framework, governments are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner. Market participants have an incentive to use this data because under caveat emptor they are responsible for all gains and losses on their investments; in short, Trust but Verify.

This blog uses the FDR Framework to explain the cause of the financial crisis and to evaluate financial reforms like the ABS Data Warehouse.